Why the Russkies Need Bucks

The Coming Soviet Crash: Gorbachev's Desperate Pursuit of Credit in Western Financial Markets, by Judy Shelton, New York, The Free Press, 246 pages, $22.50

Shortly after the euphoria of VCW Day (Victory in the Cold War, marked by Gorbachev's speech before the United Nations on December 7, 1988), New York's Sen. Daniel Moynihan (D) mused, "Will the next super-power competition be the drive to replace the United States as the world's largest debtor?" The United States has a commanding lead, but as Judy Shelton shows in her new book, The Coming Soviet Crash, the Soviet Union is poised to give us a good run for our money.

Shelton, a senior fellow at the Hoover Institution, starkly details the Soviet Union's desperate economic situation. She carefully describes the financial debacle confronting the Soviets unless Western governments and bankers can be cajoled into bailing them out. The key to Soviet economic disarray is decades of massive budget deficits. Only this past October did the Soviets admit that they have been running huge deficits. The U.S. federal budget deficit at only 3 percent of GDP is a piker when compared to the whopping Soviet deficit running at an incredible 11 percent—nearly four times greater.

Despite the Soviets' new candor, they still do not admit what Shelton shows to be the case: that the massive shortfall in the Soviet budget is not a recent phenomenon. Since 1970, the Soviet deficit has grown from an already breathtaking 20 percent to more than 30 percent of the budget.

How did the Soviets end up in this fiscal nightmare? The government pumps billions of rubles into failing industrial enterprises—some 24,000 firms are unprofitable. By adroit accounting, these rubles are treated as loans to be paid back out of future increases in the enterprise's productivity. The catch is that there are no productivity gains.

The Brezhnev years have been dubbed the Era of Stagnation for very good reason. The "loans" are really subsidies to Soviet industry. These subsidies are used to pay the salaries of workers who would like to spend them on consumer goods. Consumer goods are, however, few and far between in the Soviet Union. So Soviet citizens put their rubles into savings accounts. The Soviet Union may be the only country where increased savings is actually a sign of economic ill health. From 1970 to 1986, deposits grew from 47 billion rubles to 243 billion rubles—more than five times. Why? Not because somnolent Soviet workers were suddenly infected with the good old Protestant work ethic, but because they simply had nothing on which to spend their money.

This flood of rubles has not caused overt inflation for the simple reason that Soviet central planners have refused to let prices rise. In the United States, inflation shows up as higher prices, whereas in the Soviet Union it shows up as shortages. This results in longer and longer queues for fewer and fewer goods and in corruption in burgeoning black markets. If Soviet price controls were lifted, this suppressed inflation would explode. Given the civil unrest caused by higher prices in Poland, ballooning inflation would probably sweep away the current leadership and possibly even endanger the whole Soviet regime. Ironically, Lenin's prescription that the way to undermine capitalist economies is to "debauch the currency" turns out to be just as true for communist economies.

General Secretary Gorbachev, in an attempt to resuscitate his flagging economy, has cobbled together a program of economic restructuring, the famous perestroika of which we hear so much in the West. Perestroika is supposed to increase revenues from Soviet enterprises by forcing them to become more productive. Enterprises are expected to become self-financing. Also, the government itself is to cut costs and be decentralized. Finally, prices are slated to increase substantially.

But this ambitious plan can only succeed if Soviet workers can be persuaded to tolerate higher prices, unemployment, and more hard work. "Workers will be forced to work harder for less money, and the money will not go nearly as far in view of the rising prices," writes Shelton. "In short, perestroika is a financial squeeze for the average Soviet consumer."

Clearly, paying workers more worthless rubles won't motivate them to improve productivity. This is where the West comes in. Our role is to supply the consumer goodies that will make Soviet workers more tractable during the transition to perestroika. "Let the West provide the carrot for Soviet workers to get perestroika rolling," observes Shelton.

Western technology is also vital to improving the productivity of Soviet enterprises. Shelton persuasively argues that if Gorbachev cannot get perestroika going, then the game is lost anyway, so he has nothing to lose by borrowing as much as he can in order to finance his gamble.

And borrow Gorbachev has. New Soviet financial initiatives have been fast and furious. Since Gorbachev took office in 1985, Soviet borrowing has jumped by more than 50 percent. All this borrowing is occurring at a time when the Soviet Union's two major hard-currency exports, oil and weapons, are being hammered on world markets.

Finally, a desperate Soviet Union is trying to entice Western companies into joint ventures with Soviet enterprises. Just how Western businessmen will be able to repatriate their profits, if any, is a detail to be worked out later.

Gorbachev's gamble on perestroika is already in deep trouble. Decentralization, enterprise self-financing, and price reform are all lagging way behind schedule. In January, he reportedly pleaded with skeptical colleagues to give perestroika more time. He asserted that the current, severe shortages of food and consumer goods are not the fault of his economic initiatives. He blamed the situation on decades of huge budget deficits that had been thoroughly concealed from the Soviet Union's citizens (and Western bankers). Gorbachev even called the budget deficit "the gravest heritage of the past." Nevertheless, he declared, "There is no basis for pessimism, despondency, let alone panic." But as Shelton shows, there is.

In view of the serious situation within the Soviet Union, what should the West do? Many policymakers argue that, because he represents truly new thinking in the Kremlin, we must help Gorbachev succeed. They hold out the hope that this time the West has an opportunity to wean the Soviets from totalitarian communism.

Shelton urges Western leaders not to succumb to the current end-of-the-Cold-War euphoria. By rushing to bail out the Soviets, the West will be giving up real economic resources in return for ephemeral political concessions. As we all know, the promise of any politician can be revoked overnight, but a factory lasts a bit longer. And capital is fungible. "Funds can be used to produce washing machines, run prisons camps, or build nuclear warheads," writes Shelton. When goods are manufactured outside the Soviet Union, paid for with Western credit, and then imported for use in the internal Soviet economy, they permit scarce Soviet resources to be deployed elsewhere—Afghanistan, Angola, Cuba, Vietnam, Nicaragua. The West should heed French political commenter Jean-François Revel, who recently wrote: "If we are truly aiming to induce the great Communist systems to democratize, the one thing we must not do is help them surmount their crises while remaining communist. For unless the sickness is allowed to run its course, they will never fundamentally change."

Shelton's book is a thought-provoking and timely warning to the West that rocky times are inevitably ahead for the Soviet Union as communism slowly strangles itself on its own internal contradictions.

Ronald Bailey is a Forbes magazine staff writer.